COLUMN-Fed playing patience as inflation lags: James Saft

(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

Dec 17 (Reuters) - Call it patience or any of the rest of the seven virtues if you like, but the truth is that the Fed can't raise interest rates because inflation won't play along.

The Federal Reserve said on Thursday it is prepared to be "patient" before hiking rates but that this means the same as its former future guidance of a "considerable time."

Fed chair Janet Yellen at the press conference was pretty straightforward. Don't look for hikes at either of the next two meetings, so not before April at the earliest. She did say that "almost all participants" see rate hikes in 2015, which given there were three dissenting voters in the room is a strong prediction.

But when, exactly, in 2015 moves further and further into the future every time the Fed meets and lets us in on its virtues. Traders are now betting on a first hike in October, as compared to September before the Fed kept rates on hold and delivered its dovish statement.

A look at the forecasts the Fed released along with the statement gave a good indication of what is actually going on. Not only were the forecasts for inflation in 2015 through 2017 all lower than a month ago (and no wonder given the cratering in energy prices) but even the longer-run projection was only 2.0 percent. The Fed really isn't betting any time soon on wage growth driving inflation back to target much less above it.

This somewhat undermines all the talk about oil price falls being transitory. Not so transitory that we might see a rebound above 2.0 percent.

Consider as well the famous 'dot chart' showing Fed forecasts. The median dot for CPI in 2015 fell all the way to 1.3 percent from 1.75 percent, and even in 2017 is now 1.9 percent, down from 1.95 percent.

This implies the Fed sees no threat of too high inflation and quite a bit of threat of inflation being too low for long enough to try one's patience.

There was also a pointed reference to inflation expectations in the FOMC statement. These are trending sharply lower on a five-year view, painting a story in which disinflationary thinking is becoming embedded in people's heads.

HUMILITY

And the Fed sees stubbornly low inflation coming along with more than full employment. Fed forecasts for 2016 and 2017 have unemployment running below the long-run 'natural' rate.

This is happening, Yellen said, because "inflation is running below our objective and the committee wants to see inflation move back toward our objective over time."

"A short period of very slight undershoot of unemployment, below the natural rate, will facilitate a slightly faster return of inflation to our objective," she said.

"It is, I should say, a very small undershoot in a situation where there is great uncertainty about exactly what constitutes maximum employment."

Inflation hawks might look at that and conclude that the Fed is willing to allow the labor market to overheat a bit in order to try to bring inflation back and clear all of that disinflationary thinking from consumers' heads.

Possibly, but also possible is the idea that the reservoir of people who would like to work is large enough, and the types of jobs being created low paying enough, that we really won't see a 'normal' wage spiral take hold. If wages do start to move, the Fed will change tack very quickly, but there isn't a lot of reason to be confident that wages will rise strongly.

With this as a backdrop there is no way the Fed can hike soon, or for a "considerable time", even with labor markets doing well.

The upshot for financial markets is straightforward. Risk is on. Equities should love this, and even high-yield and credit will benefit, because the Fed is not going to be crashing that market on purpose any time soon. Emerging markets are a notable beneficiary too.

One virtue the Fed seems to be learning about, though not talking too much about is 'humility'. They continue to use tools ill suited to the job of creating inflation in a deflationary world. Hasn't worked so far, and probably won't in future, so we may be patient for a long time. (At the time of publication James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. You can email him at jamessaft@jamessaft.com and find more columns at blogs.reuters.com/james-saft) (Editing by James Dalgleish)